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The MACD or The Moving Average Convergence Divergence was by Gerald Appel, It is one of the most popular indicators. It is a very simple reliable Indicator. Also it is an Indicator a TA enthusiast gets introduced to first. The MACD is constructed by subtracting the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits. The MACD is considered to be a momentum oscillator though it is widely used by Trend followers. The most popular formula for the MACD is the difference between the 26-day and 12day exponential moving averages. I will use this standard setting and later if time permits I will try to present other combinations. A 9-day EMA of the MACD line is used as the signal line.
Chart 1 A positive MACD indicates that the shorter EMA is greater than the longer EMA indicating that momentum is positive. A rising MACD indicates the difference between the short EMA and the long EMA is increasing and in other words indicates a rising momentum. In the same way a negative MACD indicates that momentum is negative and a falling MACD indicates an increasing negative Momentum.
KARTHIK MARAR
KARTHIK MARAR
KARTHIK MARAR
One of the most important signals based on the MACD is DIVERGENCE. We will postpone discussion on this till little later. Now Let us take a deeper look at the MACD charts and try to learn a little more about the additional signals that we get and how to trade them. So far we were talking about Bullish crossover after a downtrend. In this case the Bullish crossover occurred below the zero line. However the Bullish crossover can occur above the zero line. Such crossover occurs when the stock dips temporarily before proceeding with the up trend. Such crossovers above the zero line produce some excellent trades. Bearish crossovers occurring above the zero line generally acts as warning signals as it indicates waning of the positive momentum. Bearish crossover below the zero line indicates strong bearishness.
For the making the discussion more interesting we will first make a system with the following criteria. BUY when there is a Bullish MA crossover. SELL when there is a Bearish MA crossover. Additionally the zero line bullish crossovers will be marked with an encircled number 1 with an arrow pointing upwards in order to indicate that the momentum has indeed reversed. Bullish crossovers above the zero line will be marked an encircled number 2 and arrow pointing upwards indicating good trade opportunities. Similarly bearish crossover above the zero line will marked 3 and bearish crossover of the zero line will be marked 4. A chart and an Indicator with these signals enclosed Next we will see if we can find more signals
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Chart-3
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Chart-4
It will be nice if we can indicate the Hooks on the Indicator and the chart. We will represent the DIPs during the up trend as green dots on the Indicator and green up arrows on the charts. Green stars will represent the HOOKs. On the Chart the HOOKs will be coincide with a BUY. In the same way DIPs during a downtrend will be represented by an orange dot on the Indicator and an orange down arrow on the chart. The HOOKs will be represented by a orange star and will be accompanied by a sell signal on the chart. The DIPs are good add-on/short term trade opportunities during the up trend and good warning points during the downtrend.
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The HOOKS represent a stronger Buy/Short opportunities if we combine with other indicators. Sideways markets produce lot of alternating Hooks Of course we have to have a lot of discretion when we used the Dips and Hooks. Later we will take some example to see how we can use these additional signals.
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Example -1
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. Example 2
RULE: Bearish signals like ZL crossover, MA Crossover, Dips and Hooks are effective when the ADX is rising and DI- is also rising and both ADX and DI- are above D+.
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RULE: Bullish signals are ineffective when the ADX are ineffective when the ADX is rising along with DI- and both are above D+.
RULE: When Bullish and Bearish signals are appearing alternately in quick succession it shows period of indecision and better to stay away . Since ADX is a lagging indicator many times the ADX reacts only after a BUY or SELL condition occurs. In such case it is better to eye ball the charts and enter/exit a few days after the Buy/Sell condition. Many times a Power dips comes after a BUY condition indicating good entry opportunity. Check out Example 2
Example 3
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Example- 4
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Example- 5
Another good use of the Stochastic with MACD is it helps in finding good entry/pyramiding or add on opportunities. When the stochastic is coming down from over bought region and turn back and if the MACD is positive it represents good bullish moves. In a similar way when the stochastic is rising from the over sold region and then turns back and if the MACD is negative it represents strong bearish moves. This provides good shorting opportunities. See Example 6.
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Example- 6
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Rule: When the Weekly MACD falls below the signal line it is time to consider exiting if you are still in.
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MACD HISTOGRAMS
Another way to plot the MACD is as a Histogram. The MACD Histogram is nothing but the difference between the MACD line and the signal line plotted as a Histogram. The Histogram line oscillates above and below the zero line rising above the zero line to make a positive peak and then falls below the zero line to make a negative peak.
Chart -8
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Chart 9
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In the same way zero line cross over to negative side are more effective when the histogram is also negative and falling. Also the shorting when the histogram is negative and the weekly MACD turns negative. Chart 9 Provides some Examples.
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DIVERGENCE
Next we will look at Divergences in the MACD. In technical Analysis Divergence is said to occur when an Indicator movement does not agree with the price movement. Divergence can be Bullish or bearish. If the indicator is making lower highs when the price is making a higher high there is supposed to a bearish divergence. In the same way when the Indicator makes higher lows when the price makes lower lows there is a Bullish divergence. Divergence indicates a reversal in the current trend. We can use Divergence in the MACD itself or in the MACD histogram. Dr. Elder considered Divergences in the MACD Histograms as one of the most powerful signals available to the Technical Analyst.
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However in case of Divergence one has to wait for a confirmation. Convergences are known to fail frequently. Such failures were quite evident on the Nifty in the recent past. An example of a Bearish Divergence shown in the chart of Apollo tyre (Chart-11) clearly forewarn the impending weakness
Chart-11 An Example of Bullish Divergence is given in the chart of Asian Electric (Chart-12). When the stock was making a lower low the MACD made a Higher Low in July last.
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Chart -12 Now let us look at the Divergences in MACD Histogram. I find divergences in Histogram more useful than divergence in the MACD itself. It is also one of the favorite tools for Dr.Elder. Many items the Histogram throws up divergence even there is no divergences detected in the MACD. Similar to the MACD divergence when the peaks do not correlate to the stock peaks and troughs. A bullish Divergence occurs when the histograms makes a negative peak smaller than the previous one when the stocks make a lower low. In the same manner a Bearish divergence occurs when the histogram makes a positive peak smaller than the previous one and the stock make a higher high. Chart 13 and Chart 14 provides some examples.
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Finally it always good to look at the volume while looking at the MACD. Combing Volume with MACD helps us to get onto some really good moves. There could be many ways to combine this. One could just use a simple moving average of the volume or look at some volume-based indicator. OBV indicator with a 30 day moving average of the same does work as a good confirmatory Indicator. We can also derive a MACD with a volume bias. There are many ways to do that. I will not go into the details of these here. I will provide a simple example here. Create a new variable V= sum(C*V)n / sum (V)n Now create a MACD of this variable with n=12 and n=26. I will leave the experimentation to you. Just enclosing the chart of this volume biased MACD with the normal MACD
Chart-15
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Now it is time to conclude this discussion on trading the MACD. Before that we will just look at the pros and cons of the MACD. MACD-PROS MACD can be a trend following as well as a momentum Indicator. Since we are using two moving averages it makes a good trend following Indicator. As a momentum Indicator it captures the underlying momentum and that is the reason divergences are very effective in case of MACD. Divergence forewarns the traders of the impending weakness and reversals. MACD can be used on any time frame effectively. MACD is one of the most widely followed Indicators and that makes it self-fulfilling and effective. MACD- CONS Since MACD is based on moving averages the inherent qualities of lag and whipsaws are also reflected in the MACD. MACD as a momentum Indicator does not work well as a indicator of over bought and oversold levels. END NOTE MACD used properly can be one of the simplest and rewarding tool for the Technical Analyst. However it does have drawbacks and combining it with other Indicators makes it very effective. One can try the MACD with different combination of the moving averages instead of the standard 12, 26. Many people use a shorter period for example 8,17,9 for Buy and longer ones 12,26,9 for sell. Also one can experiment with MACD of other types of moving averages like weighted Moving averages, Adaptive moving averages like KAMA, VIDYA, and MAMA etc.
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